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Option exercise with temptation

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  • Jianjun Miao

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Abstract

This paper analyzes an agent¡¯s option exercise decision under uncertainty. The agent decides whether and when to do an irreversible activity. He is tempted by immediate gratification and suffers from self-control problems. This paper adopts the Gul and Pensendorfer self- control utility model. Unlike the time inconsistent hyperbolic discounting model, it provides an explanation of procrastination and preproperation based on time consistency. When applied to the investment and exit problems, it is shown that (i) if the project value is immediate, an investor may invest in negative NPV projects; (ii) if the production cost is immediate, a firm may exit even if it makes positive net profits; and (iii) if both rewards and costs are immediate, an agent may simply follow the myopic rule which compares only the current period benefit and cost.

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 34 (2008)
Issue (Month): 3 (March)
Pages: 473-501

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Handle: RePEc:spr:joecth:v:34:y:2008:i:3:p:473-501

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Related research

Keywords: Time (in)consistency; Self-control; Temptation; Procrastination; Preproperation; Real options; D81; D91; G31;

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  1. Faruk Gul & Wolfgang Pesendorfer, 2004. "Self-Control and the Theory of Consumption," Econometrica, Econometric Society, Econometric Society, vol. 72(1), pages 119-158, 01.
  2. Ted O' Donoghue & Matthew Rabin, 2001. "Choice and Procrastination," Microeconomics, EconWPA 0012002, EconWPA.
  3. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
  4. Matt Shum & S Esteban & E Miyagawa, 2003. "Nonlinear Pricing with Self-Control Preferences," Economics Working Paper Archive 503, The Johns Hopkins University,Department of Economics.
  5. Brocas, Isabelle & Carrillo, Juan D, 2001. " Rush and Procrastination under Hyperbolic Discounting and Interdependent Activities," Journal of Risk and Uncertainty, Springer, vol. 22(2), pages 141-64, March.
  6. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, University of Chicago Press, University of Chicago Press, vol. 14(2), pages 189-99, September.
  7. Steven R. Grenadier & Neng Wang, 2006. "Investment Under Uncertainty and Time-Inconsistent Preferences," NBER Working Papers 12042, National Bureau of Economic Research, Inc.
  8. Ted O'Donoghue & Matthew Rabin, 1996. "Doing It Now or Later," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1172, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  9. Per Krusell & Burhanettin Kuruşçu & Anthony A. Smith Jr., 2010. "Temptation and Taxation," Econometrica, Econometric Society, Econometric Society, vol. 78(6), pages 2063-2084, November.
  10. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
  11. Ted O'Donoghue & Matthew Rabin, 1997. "Incentives for Procrastinators," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1181, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  12. David K. Levine & Drew Fudenberg, 2006. "A Dual-Self Model of Impulse Control," American Economic Review, American Economic Association, vol. 96(5), pages 1449-1476, December.
  13. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
  14. Per Krusell & Burhanettin Kuruscu & Anthony A. Smith, Jr., . "Time Orientation and Asset Prices," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 2001-13, Carnegie Mellon University, Tepper School of Business.
  15. W. Pesendorfer & F. Gul, 1999. "Temptation and Self-Control," Princeton Economic Theory Papers, Economics Department, Princeton University 99f1, Economics Department, Princeton University.
  16. Per Krusell & Anthony A Smith, Jr., 2001. "Consumption Savings Decisions with Quasi-Geometric Discounting," Levine's Working Paper Archive 625018000000000251, David K. Levine.
  17. Stefano DellaVigna & M. Daniele Paserman, 2005. "Job Search and Impatience," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 23(3), pages 527-588, July.
  18. Ayse Imrohoroglu & Selahattin Imrohoroglu & Douglas H. Joines, 2000. "Time inconsistent preferences and Social Security," Discussion Paper / Institute for Empirical Macroeconomics 136, Federal Reserve Bank of Minneapolis.
  19. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  20. DeJong, David N. & Ripoll, Marla, 2007. "Do self-control preferences help explain the puzzling behavior of asset prices?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(4), pages 1035-1050, May.
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Citations

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Cited by:
  1. Tsvetanov, Tsvetan & Segerson, Kathleen, 2013. "Re-evaluating the role of energy efficiency standards: A behavioral economics approach," Journal of Environmental Economics and Management, Elsevier, vol. 66(2), pages 347-363.
  2. Isao Shoji & Sumei Kanehiro, 2012. "Intertemporal dynamic choice under myopia for reward and different risk tolerances," Economic Theory, Springer, Springer, vol. 50(1), pages 85-98, May.
  3. Fudenberg, Drew & Levine, David, 2006. "A Dual-Self Model of Impulse Control," Scholarly Articles 3196335, Harvard University Department of Economics.
  4. Kyle Hyndman & Alberto Bisin, 2009. "Procrastination, Self-Imposed Deadlines and Other Commitment Devices," Departmental Working Papers 0904, Southern Methodist University, Department of Economics.
  5. Klaus Nehring, 2006. "Self-Control through Second-Order Preferences," Levine's Bibliography 321307000000000391, UCLA Department of Economics.
  6. Hsiaw, Alice, 2013. "Goal-setting and self-control," Journal of Economic Theory, Elsevier, vol. 148(2), pages 601-626.
  7. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
  8. Tsvetan Tsvetanov & Kathleen Segerson, 2011. "Re-Evaluating the Role of Energy Efficiency Standards: A Time-Consistent Behavioral Economics Approach," Working papers 2011-24, University of Connecticut, Department of Economics.
  9. Daniel Houser & Daniel Schunk & Joachim Winter & Erte Xiao, 2010. "Temptation and commitment in the laboratory," IEW - Working Papers 488, Institute for Empirical Research in Economics - University of Zurich.
  10. D.Dragone, 2005. "Incoerenza Dinamica ed Autocontrollo: Proposta per un'Analisi Interdisciplinare," Working Papers 549, Dipartimento Scienze Economiche, Universita' di Bologna.

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